Saturday, April 18, 2009

When Zero Hedge first presented its thesis about a likely upcoming mega squeeze in Citi common concurrent with the bank's shares trading at $1, some readers expressed their dismay with our lack of intellectual capacity. Less than two months later, and $3 dollars higher, the situation has changed... at least for the Citi shorts.

However, has the situation changed for the bank itself? Citi, along with the the rest of the banking sector beat modest earnings expectations. But is Citi to be lumped into the JP Morgan and Goldman Sachs camps, the latter guilty of such Julian to Gregorian legerdemain that it makes the alleged $3 billion in commodity-related undermarks in December (and funneling them through FICC no less) and subsequent MTM reversion seem tame in contrast. Egan Jones, easily the best rating agency (which is not really saying much when your competition is the buffoonery conglomerates known as S&P and Moody's), had the following choice words in their developing analysis of Citigroup:

Accounting and government magic - the recasting of FASB157 enables financial institutions to defer the recognition of losses with the result that C's March trading profits swung from a $6.8B loss to a $3.8B gain. Another item worth reviewing is the decline in interest expense from $16.5B last year to $7.7B this year. Nonetheless, much more equity capital is needed. Beyond the conversion of preferred to common, watch the form of any additional capital. The Fed and Treas. have guaranteed $306B of C's assets, have injected $45B in preferred and converted to common leaving few additional options. The problem is that C has $2T of assets ($3+T including off balance sheet assets) whose values are depressed by 10% to 20%. C needs to be watched.

Egan Jones is not alone in their condemnation of Citi's grotesque Criss Angel-esque interpretation of reality. The consensus seems to be thumbs down for the bank, even though the latter, together with the balance of the worst companies in the S&P, has benefited mightily from the less and less connected to reality "crap rally" (but more and more connected to quant fund deleveraging and viability).

What happens now? The market has reached a very curious inflection point, which is eerily reminiscent of what happened to the basis trade in the post-Lehman days (just ask Boaz Weinstein for advice if the equity market is cheap now). Liquidity is disappearing - in fact with every market uptick more and more quants and L/S funds deleverage if they can, while some are stuck and have turned their phones off entirely. Ironically, the higher the market goes, the higher the probability that we will see not just a few small quants blowing up, but some of the big guys also taking a bullet to the temple. In a hypothetical case where a $100 billion+ provider of market liquidity ceases to function the market will break, pure and simple: this is not a directional bet, this is a volatility bet.

Ironically Citi common is now the basis trade reincarnated in the ongoing market melt up. As liquidity becomes scarcer and scarcer, Citi's stock price is likely among the best barometers: this manifests in lack of borrow, in high trading costs, increasing repo rates, as well as the threat, despite repeated promises to the contrary, of an adjustment in the common-preferred conversion rate. In an extreme example it is easy to see the stock skyrocketing to multiples of its current price, however when (not if) fundamentals take over, the way down will be quick and painful.

And while Jim Cramer likely top ticks the rally yet again, and Barney Frank wants to guarantee every risky asset in the United States in another misguided attempt of postponing the D-Day for all the fiscal and monetary insanity happening in this country, the FDIC announces that 2 more banks have failed (bringing the 2009 total to 25), which will cost the FDIC (aka taxpayers) $100 million and $143 million, respectively. And while we are on the topic: Sheila, maybe you can at least tells us if the FDIC's Depository Insurance Fund has finally gone negative, especially now that your brilliant actions have made it unneccesary for banks to use the TLGP and thus pay the FDIC the recently increased TLGP fee?

PS: Based on these headlines, maybe Messrs Dudley and Kohn can join Mr. Cramer in the Wall Street Top Tickers cheerleading camp (Zero Hedge to provide its thoughts on Mr. Kohn's misrepresentation of reality shortly). Then again, if even the market custodians of the Federal reserve are doing all they can to get every last retail investor to believe this bear market rally is for real and incite a market liquidity event, then there truly is no hope.Fed’s Dudley Says Fears of Scrutiny Under TALF Are ‘Misplaced’

When Zero Hedge first presented its thesis about a likely upcoming mega squeeze in Citi common concurrent with the bank's shares trading at $1, some readers expressed their dismay with our lack of intellectual capacity. Less than two months later, and $3 dollars higher, the situation has changed... at least for the Citi shorts.

However, has the situation changed for the bank itself? Citi, along with the the rest of the banking sector beat modest earnings expectations. But is Citi to be lumped into the JP Morgan and Goldman Sachs camps, the latter guilty of such Julian to Gregorian legerdemain that it makes the alleged $3 billion in commodity-related undermarks in December (and funneling them through FICC no less) and subsequent MTM reversion seem tame in contrast. Egan Jones, easily the best rating agency (which is not really saying much when your competition is the buffoonery conglomerates known as S&P and Moody's), had the following choice words in their developing analysis of Citigroup:

Accounting and government magic - the recasting of FASB157 enables financial institutions to defer the recognition of losses with the result that C's March trading profits swung from a $6.8B loss to a $3.8B gain. Another item worth reviewing is the decline in interest expense from $16.5B last year to $7.7B this year. Nonetheless, much more equity capital is needed. Beyond the conversion of preferred to common, watch the form of any additional capital. The Fed and Treas. have guaranteed $306B of C's assets, have injected $45B in preferred and converted to common leaving few additional options. The problem is that C has $2T of assets ($3+T including off balance sheet assets) whose values are depressed by 10% to 20%. C needs to be watched.

Egan Jones is not alone in their condemnation of Citi's grotesque Criss Angel-esque interpretation of reality. The consensus seems to be thumbs down for the bank, even though the latter, together with the balance of the worst companies in the S&P, has benefited mightily from the less and less connected to reality "crap rally" (but more and more connected to quant fund deleveraging and viability).

What happens now? The market has reached a very curious inflection point, which is eerily reminiscent of what happened to the basis trade in the post-Lehman days (just ask Boaz Weinstein for advice if the equity market is cheap now). Liquidity is disappearing - in fact with every market uptick more and more quants and L/S funds deleverage if they can, while some are stuck and have turned their phones off entirely. Ironically, the higher the market goes, the higher the probability that we will see not just a few small quants blowing up, but some of the big guys also taking a bullet to the temple. In a hypothetical case where a $100 billion+ provider of market liquidity ceases to function the market will break, pure and simple: this is not a directional bet, this is a volatility bet.

Ironically Citi common is now the basis trade reincarnated in the ongoing market melt up. As liquidity becomes scarcer and scarcer, Citi's stock price is likely among the best barometers: this manifests in lack of borrow, in high trading costs, increasing repo rates, as well as the threat, despite repeated promises to the contrary, of an adjustment in the common-preferred conversion rate. In an extreme example it is easy to see the stock skyrocketing to multiples of its current price, however when (not if) fundamentals take over, the way down will be quick and painful.

And while Jim Cramer likely top ticks the rally yet again, and Barney Frank wants to guarantee every risky asset in the United States in another misguided attempt of postponing the D-Day for all the fiscal and monetary insanity happening in this country, the FDIC announces that 2 more banks have failed (bringing the 2009 total to 25), which will cost the FDIC (aka taxpayers) $100 million and $143 million, respectively. And while we are on the topic: Sheila, maybe you can at least tells us if the FDIC's Depository Insurance Fund has finally gone negative, especially now that your brilliant actions have made it unneccesary for banks to use the TLGP and thus pay the FDIC the recently increased TLGP fee?

PS: Based on these headlines, maybe Messrs Dudley and Kohn can join Mr. Cramer in the Wall Street Top Tickers cheerleading camp (Zero Hedge to provide its thoughts on Mr. Kohn's misrepresentation of reality shortly). Then again, if even the market custodians of the Federal reserve are doing all they can to get every last retail investor to believe this bear market rally is for real and incite a market liquidity event, then there truly is no hope.Fed’s Dudley Says Fears of Scrutiny Under TALF Are ‘Misplaced’